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What's Holding Back This Search Giant?

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Today, many growing businesses in emerging markets claim to be the “next Amazon, Google (NASDAQ: GOOG) or eBay.” The prospect that a relatively small company can ride a macro growth trend in a rapidly growing economy is undeniably appealing, and Russia’s search engine Yandex (NASDAQ: YNDX) is no exception. Often called the “Google of Russia,” Yandex was once a core holding for many emerging markets investors. But since its public debut in 2011, the stock has lost nearly 30% of its value.

Despite its lackluster stock performance, Yandex still controls 60% of the search market in Russia, one of the world’s key emerging markets. If so, what’s weighing this stock down? Let’s examine some key factors.

Fundamentals first


To get a better perspective of how Yandex measures up to its competitors, we should compare its financial health to its market peers in the United States and China - Google and Baidu (NASDAQ: BIDU). 

<table> <tbody> <tr> <td><strong>Company</strong></td> <td><strong>Forward P/E</strong></td> <td><strong>PEG Ratio</strong></td> <td><strong>Price to Sales</strong></td> <td><strong>Price to Book</strong></td> <td><strong>Debt to Equity</strong></td> </tr> <tr> <td><strong>Google</strong></td> <td><span>14.25</span></td> <td><span>1.2</span></td> <td><span>5.1</span></td> <td><span>3.57</span></td> <td><span>10.05</span></td> </tr> <tr> <td><strong>Yandex</strong></td> <td><span>0.71</span></td> <td><span>1.0</span></td> <td><span>9.5</span></td> <td><span>7.28</span></td> <td><span>N/A (no debt)</span></td> </tr> <tr> <td><strong>Baidu</strong></td> <td><span>18.16</span></td> <td><span>0.65</span></td> <td><span>11.64</span></td> <td><span>10.27</span></td> <td><span>11.91</span></td> </tr> <tr> <td><em>Advantage</em></td> <td><span>Yandex</span></td> <td><span>Baidu</span></td> <td><span>Google</span></td> <td><span>Google</span></td> <td><span>Yandex</span></td> </tr> </tbody> </table>

Source: Yahoo Finance

Yandex is a very fundamentally appealing stock, with strong growth ratios and no debt. However, that’s only half the story. We should also chart its earnings and revenue growth over the past year.


<img src="http://media.ycharts.com/charts/8fe7e4a129ce5c4287a4aa662862e93b.png" />

GOOG Revenue TTM data by YCharts

From this chart, we see that even though Yandex’s revenue rose 27.57% in the past two years, its EBITDA only grew by 3.75% after posting negative growth throughout most of 2012. Notice that Baidu has done the best job of keeping revenue and earnings growth synchronized, while Google’s earnings growth has slowed considerably due to its costly acquisition of Motorola. This split between revenue and EBITDA growth tells us that Yandex’s margins are getting squeezed. The next chart confirms that.

<img src="http://media.ycharts.com/charts/b3e370a31ade860026e4c68f1d9ac565.png" />

GOOG Operating Margin TTM data by YCharts

Over the past year, Yandex’s operating margin has dropped 28.37%, while cash is barely growing at all. That means Yandex is facing the classic Internet growth problem - high revenue growth weighed down by oversized marketing and expansion costs, which cut deep into margins and profit.

Primary threats

Yandex faces no real domestic competition in Russia, but Google and Facebook (NASDAQ: FB),which can be freely accessed in Russia, are two looming threats. The fact that Google and Facebook are both banned in China has been a huge boon to Baidu and social network RenRen.

Google

Take a look at Google’s market share performance in Russia over the past three years to see why Yandex investors are worried.

<table> <tbody> <tr> <td> </td> <td><span>1/31/2011</span></td> <td><span>1/31/2012</span></td> <td><span>1/31/2013</span></td> </tr> <tr> <td><strong>Google</strong></td> <td><span>21.9%</span></td> <td><span>25.9%</span></td> <td><span>26.4%</span></td> </tr> <tr> <td><strong>Yandex</strong></td> <td><span>64.4%</span></td> <td><span>59.6%</span></td> <td> <p><span>60.5%</span></p> </td> </tr> </tbody> </table>

Source: http://www.liveinternet.ru

Despite a minor recovery over the past year, it’s clear that Yandex, which only has $384.4 million in cash, is being dominated by Google, which can wage an endless war with its $48 billion cash hoard. Factor in Android and the growing mobile market in Russia, and Yandex has a serious problem to contend with.

Facebook

Facebook, which has 7.6 million users in Russia, has also made it clear that Yandex is not welcome to search its social networks. Yandex recently launched a beta version of the Wonder mobile app, which allows voice searches of social network activities across Facebook and Twitter accounts. Yandex maintained that Wonder wasn’t a “search engine” but rather a "searchable index," but Facebook immediately took notice.

In response, Facebook cut Yandex off from its Graph API, the platform which connects third party software to Facebook. Facebook likely considered Wonder to be a competitor to its recently released “Graph Search,” which operates on a similar principle, allowing users and advertisers to intelligently search through a directory of users based on location, age, interests and more.

Despite the setback, Yandex claims that it is working on partnerships with other social networks. However, without Facebook, any mobile social networking initiative would be wasteful and pointless.

Opportunities

Despite the ongoing threats of Google and Facebook within Russia, Yandex has set its eyes on overseas expansion. The company recently announced that it had established a 2% market share in Turkey, which is often considered a key emerging market since it bridges the gap between Eastern and Western trade while controlling several key oil pipelines.

Although its share is currently small, the company believes it can secure 25% to 30% of the market in the long term. Yandex’s CEO Arkady Volozh believes that despite Google’s dominance of Turkey, there is room for “three orbital” companies in any nation’s search market - with the largest taking 60%, the second taking 30% and the last one (and other fragmented competitors) claiming 10%.

Yandex has also released its own web browser, just as Google released Chrome to lock users into its cloud-based ecosystem. Although Yandex currently lacks Google’s sprawling ecosystem of apps, it recently forged a partnership with photo-sharing app producer Cooliris, which is similar to Google’s Picasa software. Unlike Picasa, however, Cooliris is able to download and organize pictures from a myriad of online sources, such as Facebook, Instagram, Google+,Picasa, Flickr and more. Yandex also has its own cloud drive service, Yandex Disk, which resembles a fledgling version of Google Drive or Microsoft’s Skydrive.


The Foolish bottom line

Even though Russia’s Internet market hasn’t matured yet, with a 44% penetration rate compared to 79% in the United States, Google’s growing slice of the market is too hard to ignore. Whereas Baidu’s market share soared after Google’s expulsion from mainland China, Yandex has no such catalyst on the horizon. In addition to Google’s rising popularity, Yandex also must contend with Facebook, which is a dangerous wild card due to its rivalry with Google and its new Graph Search technology.

Considering these glaring vulnerabilities, as well as Yandex’s fairly weak and costly growth initiatives, I would say that the “Russian Google” is on the fast track to becoming the “Russian Yahoo” - unless it can mount a reasonable, timely defense against its American rivals.


Leo Sun owns shares of Facebook. The Motley Fool recommends Baidu, Facebook, Google, and Yandex. You can follow Leo Sun on Twitter at https://twitter.com/leokornsun for more investing ideas.

The Motley Fool recommends Baidu, Facebook, Google, and Yandex. The Motley Fool owns shares of Baidu, Facebook, and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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